Why is everyone yellin’ about Janet Yellen? Everyone wants to know about the Chair of the Federal Reserve’s plans to raise interest rates.
And it seems everyone has an opinion.
Here’s a quick breakdown on why interest rates are an especially hot topic right now:
How Low Can You Go?
The Federal Reserve (better known as The Fed) sets interest rates “to help set the backdrop for promoting the conditions that achieve maximum sustainable employment, low and stable inflation, and moderate long-term interest rates.”
In 2008, the Fed made a number of financial decisions to ease the shock of the Great Recession, when the nation was hit with a banking and housing crisis. One of these ways was to lower interest rates to near zero.
This was seen as a way to jumpstart the wheezing economy by encouraging employment, economic growth and spending. The theory: Lowering the Fed’s key interest rate would keep people spending on the things that help make the American economy grow.
Lower interest rates would encourage Americans to start spending money again, thereby stimulating growth. Recession-scared people could obtain mortgages for new homes or construction or say, a new car at a lower rate.
Businesses would also benefit from lower interest rates. They would have incentive to buy equipment, hire more employees, remodel, and build new factories because they’d be able to borrow cheaply. In short, they could plan for the future.
The Fed kept interest rates at this low level for years, only incrementally raising them in 2015. Yellen surmised that the economy had recovered enough from the Great Recession to handle a gentle increase in interest rates.
Why raise interest rates?
Low interest rates sound pretty good! Cheap rates on mortgages and cars. What could be bad? Here’s the thing. Interest rates affect more than just the things we buy. They affect how much we save.
A low interest rate economy might be great for spenders but it makes life tough for savers. With low rates, people who hold variable interest rate debt (debt that can increase or decrease, such as an adjustable rate mortgage or interest on a credit card) have seen the value of their debt effectively decrease. But people who hold bond investments run the risk of negative investment returns when rates rise again.
The other problem with keeping interest rates artificially low: there’s nowhere to go from near-zero in the event we fall into another recession.
Keeping rates this low has been controversial. Some economists believe that allowing Americans to believe that this era of easy lending will never end creates a false economic reality — and could lead to another bubble.
What’s Happening Now
It isn’t a matter of if the Fed will raise interest rates. It’s how quickly.
“Waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road – either too much inflation, financial instability, or both,” she told the Commonwealth Club of California in San Francisco back in January.
Policymakers are expected to raise the rate “a few times a year” through 2019, putting it near the long-term sustainable rate of 3 percent.
Increasing interest rates will affect those looking to buy homes or make large investments in their business as well as interest on credit cards. It will also affect banks and their ability to lend money
Ultralow interest rates were put in place to prop up the American economy when it was struggling from the Great Recession. By easing interest rates back up, the hope is that Americans will start saving (and continue spending), that the U.S. dollar will strengthen and that employment will stay steady.
A slow raising of interest rates aren’t felt right away. Changes in monetary policy (which includes interest rates) can take up to 18 months for the economy to feel — and react.
Is America ready for higher interest rates? We’ll have to wait and see.
Keep learning: Quiz: Do you know these amazing women in finance?
- FRB: Why Do Interest Rates Matter?, FederalReserve.gov
- The Great Recession and Its Aftermath, FederalReverveHistory.gov
- Fed Cuts Key Rate to Record Low, Washington Post, Dec. 17, 2008
- Fed Cuts Key Rate to a Record Low, New York Times, Dec. 17, 2008
- Fed Raises By 25 Basis Points, First Since 2006, CNBC.com, Dec. 16, 2015
- The Real Financial Monster: Low Interest Rates, PBS.org, Aug. 28, 2014
- How the Fed’s Interest Rate Increase Can Affect You, New York Times, Dec. 14, 2016
- In-Depth: U.S. Interest Rates, The Financial Times